Magazine article The CPA Journal

Who Is an Employee: Some Implications of SFAS No. 123

Magazine article The CPA Journal

Who Is an Employee: Some Implications of SFAS No. 123

Article excerpt

In October 1995, after much controversy and concern, the FASB issued SFAS No. 123, Accounting for Stock Based Compensation. In spite of its title, the reality is that, for most situations, SFAS No. 123 specifies "disclosure" rather than "accounting" standards, since it is clear that the vast majority of companies have opted to adopt the provisions of SFAS No. 123 by pro forma disclosure rather than by recognition and measurement.

SFAS No. 123 allows companies to continue using the provisions of APB Opinion No. 25, Accounting for Stock Issued to Employees, when accounting for stockbased awards issued to employees. However, when stock-based awards are issued to nonemployees, paragraph 8 of SFAS No. 123 states as follows:

Except for transactions with employees that are within the scope of [APB] Opinion [No.] 25, all transactions in which goods or services are the consideration received for issuance of equity instruments shall be accounted for based on the fair value of the consideration received or the fair value of the equity instruments issued, whichever is more reliably measurable.

Thus, SFAS No. 123 requires companies to determine the value of a transaction with a nonemployee and account for the transaction at its fair value when stockbased awards are issued to nonemployees.

SFAS No. 123 and APB Opinion No. 25

While SFAS No. 123 requires companies to account for transactions with nonemployees at fair value, it does not specifically define what constitutes an employee vs. a nonemployee. Instead, SFAS No. 123 refers to APB Opinion No. 25 by saying: [T]his Statement provides a choice of accounting methods for transactions with employees that are within the scope of [APB] Opinion [No.] 25."

Based on this reference, practitioners might presume APB Opinion No. 25 contains a definition of employees that will be helpful in applying the provisions of SFAS No. 123. Unfortunately, APB Opinion No. 25 does not contain any definition or discussion of the concept of employees. The distinction can be important to a company but there appears to be no guidance in the accounting literature as to who is considered an employee. The FASB's Emerging Issues Task Force has discussed two related issues: Issue No. 96-3, Accounting for Equity Instruments that Are Issued for Consideration Other than Employee Services Under FASB Statement No. 123 and Issue No. 9618, Accounting for Equity Instruments with Variable Terms that Are Issued for Consideration Other than Employee Services Under FASB Statement No. 123. In neither of these issues, however, does the EITF address the question of who is considered to be an employee. Because there is no guidance in accounting standards, a logical place to look for guidance would appear to be the law that does contain guidance on the issue.

Legal Guidance

While it is clear there are serious financial reporting consequences when stockbased compensation is given to a nonemployee, since the issuance of SFAS No. 123 companies have begun to refer to certain individuals as "employees for purposes of applying SFAS No. 123." This is frequently used in discussing the application of SFAS No. 123 to stock grants given to outside members of the company's board of directors. Unfortunately, a contractually agreed upon characterization of an individual's status will not automatically immunize the corporation or the individual from scrutiny by the courts or regulatory bodies. In fact, the status may be recast depending upon the details or relationship between individual and company in several critical areas.

At common law, there are four elements that determine whether the relationship is one of employer/employee or independent contractor:

Selection and engagement of the employee,

Payment of wages,

Power of dismissal, and

Power of control of the employee's conduct.

The essential characteristic common to each of these elements is the right of control-the right of the employer to order and control the employee in the performance of work, as well as the right to direct the manner in which the work will be done. …

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